Question

Holo Company reported the following financial numbers for one of its divisions for the year; average total assets of $5,930,000; sales of $5,505,000; cost of goods sold of $3,290,000; and operating expenses of $1,160,000. Assume a target income of 14% of average invested assets. Compute residual income for the division:

Answer 1

$224,800

Step-by-step explanation:

Given that,

Average total assets = $5,930,000;

Sales = $5,505,000;

Cost of goods sold = $3,290,000

Operating expenses = $1,160,000

Target income = 14% of average invested assets

Residual income is calculated by the following formula:

= Net income - Target income

= Net income - (Average operating assets × Return)

So, there is a need to calculate the net income first. It is calculated as follows:

Gross profit = Sales - Cost of goods sold

= $5,505,000 - $3,290,000

= $2,215,000

Net income = Gross profit - Operating expenses

= $2,215,000 - $1,160,000

= $1,055,000

Therefore, the residual income is determined by the difference between net income and target income. It is calculated as follows:

= Net income - (Average operating assets × Return)

= $1,055,000 - ($5,930,000 × 0.14)

= $1,055,000 - $830,200

= $224,800